IRS Interim Report on Compliance in the Non-profit Sector

June 8, 2010

The Internal Revenue Service released an interim report on May 7, 2010, summarizing responses to compliance questionnaires sent to 400 public and private colleges and universities in 2008. Colleges and universities make up one of the largest nonprofit segments in terms of revenue and assets as well as the most complex organizations in the tax-exempt sector. The goal of the questionnaire is to ultimately help the IRS with enforcement and service efforts for exempt organization. Areas of focus are: unrelated business activities and tax, consolidations and controlling entities, and executive compensation.

The interim report contains preliminary information on the respondents’ organizational structures, demographics, exempt and unrelated business activities, endowments, executive compensation as well as governance practices. The questionnaire got a high response rate of 97% with only 13 organizations not responding.

A large number of the organizations reported having related-entities that were other tax-exempt entities. Many of these were reported as being at least 50% controlled by the responding party. Many of these organizations then did not include income from these controlled entities in their reporting indicating some confusion on the principles of consolidation and reporting requirements.

The questionnaire also included activities that may be taxable and many responders indicated that they were involved in such activities, however when asked about unrelated business tax and filing 990-T, the same responders did not include these activities on the 990-T. Whether or not something should be considered an unrelated business activity can be a nebulous thing and organizations should not hesitate to ask for guidance if there is any confusion. In the most general terms, if it doesn’t further the purpose of your organization’s mission, it needs to be assessed as to whether it is taxable or if it is otherwise exempt. Selling t-shirts with the organization’s slogan and logo at a conference would be considered unrelated activity. Interest income received from investments is otherwise exempt.

The questionnaire delved into executive compensation and the methodology for determining key employee salary. Most respondents utilize a “rebuttal presumption procedure” for determining compensation as opposed to comparative data. A rebuttal presumption is one that assumes the given is true until someone comes forward with evidence to the contrary. With the IRS placing closer scrutiny on executive compensation in the tax-exempt sector, they may well be challenging the presumption. Having some sort of comparative analysis of competitive salaries in similar organizations is a better way to substantiate that your executive pay is reasonable.

The IRS will continue to analyze the data. Additional information will be included in a final report.

The IRS has opened examinations of more than 30 organizations that were selected based on responses to the questionnaire. These examinations focus primarily on unrelated business income and executive compensation issues.